India Hyatt Ruling Means MNEs Must Review Control Structures

The Supreme Court of India’s landmark ruling in the Hyatt case has shifted the ground for multinational enterprises in India. This ruling goes beyond the technical interpretation of tax laws, and in the process has reinforced the principles of substance over form and economic reality in determining permanent establishment.

The Hyatt ruling is a significant landmark in India’s tax jurisprudence, as it reinforces the principle of substance over form, aligning with global trends in tax treaties and the introduction of anti-abuse provisions, such as the principal purpose test. Contractual semantics won’t hold; it is the operational reality that will determine the tax outcome.

For multinationals, it could lead to heightened scrutiny of cross-border arrangements, eventually prompting a need for review of existing arrangements and restructuring to mitigate tax exposure.

At the heart of the dispute was the question: Did the global hotel chain’s operations in India, which were limited to advisory and supplementary functions, constitute a permanent establishment?

The court’s decision goes beyond the traditional permanent establishment principles. It lays down some significant principles regarding attribution of profits to a permanent establishment in India and is set to have tangible implications for multinationals.

In reaching its decision, the court underscored the principle that functional control is the key to determining the substance of a transaction and is as crucial as physical presence—and in certain instances can supersede the requirement for physical presence.

It’s been made clear that a permanent establishment can exist without a fixed physical office if the foreign entity exercises operational control.

The ruling relies on, and expands, the disposal test formulated in the Formula One case that a grant of a formal right to use the Indian premises isn’t essential to constitute a permanent establishment. It’s sufficient if the premises were, in substance, at the disposal of the foreign entity and core business functions were conducted from there.

Further, use of a temporary or shared space suffices if the business is carried on through that space, and exclusive possession of a space isn’t material.

The court dismissed Hyatt’s claim of being a mere adviser to Indian hotels and went into the substance of the arrangement rather than the mere terminology used to describe the role of Hyatt in the contract. Vital in this was the 20-year service operation support agreement that granted Hyatt the rights to:

• Appoint and supervise the general manager and key personnel.
• Implement human resources and procurement policies.
• Control pricing, branding, and marketing strategies.
• Manage operational bank accounts.
• Assign personnel to the hotel without requiring consent from the owner.

The court noted that these clauses transformed what was held out contractually to be an advisory role into complete operational control, demonstrating that Hyatt maintained significant and enforceable control over the hotel’s strategic, operational, and financial aspects.

The court emphasized that Hyatt’s entitlement to a strategic fee, calculated as a percentage of the hotel’s revenue, reflected Hyatt’s active involvement in the hotel’s financial and operational performance.

It’s significant that the court clarified that an Indian permanent establishment is a distinct and separate taxable entity, and that profits from Indian operations can be taxed locally, even if the multinational is incurring global losses.

This aligns with the principle that the source state has complete tax sovereignty over profits generated from business operations within its jurisdiction, which the Indian Supreme Court in GVK Industries Ltd. has already recognized.

The ruling reinforces that labels aren’t relevant. Tax authorities can pierce the commercial and economic substance veil of the arrangements. This is an invitation to apply tax anti-avoidance tools, such as general anti-avoidance rules and the principal purpose test, to align tax outcomes with ground realities.

The ruling also clarifies that the period of stay of individual employees in India is immaterial and the relevant consideration for the existence of a permanent establishment is the continuity of the foreign entity’s business operations in India in aggregate.

Implications for Multinationals

The Hyatt ruling potentially exposes vulnerabilities in various legacy arrangements put in place by multinationals in India.

Redefined thresholds. Traditional permanent establishment thresholds may no longer be the only relevant factors. Contracts that grant control, revenue sharing, or multi-year operational involvement will now face potential permanent establishment risks.

Profit attribution challenges. Reliance on global losses to argue and mitigate tax liability in India may not work. Tax authorities likely will seek accounts laying out India-specific profitability, which can also escalate transfer pricing-related disputes.

Retrospective exposure. Existing long-term contracts that include rights granting operational control and broader rights about business management risk reclassification as permanent establishments, potentially triggering taxes, penalties, and interest for past periods.

To navigate the new markers laid down by the Indian Supreme Court, multinationals can consider the following:

• Review contracts. Conduct a comprehensive review of existing contracts to identify clauses similar to a service operation support agreement and assess whether they enable multinationals to exert control over Indian operations.
• Use caution on handing over operational control. Limit the entitlements of the foreign enterprise under franchise or quality control agreements so that such an entity isn’t seen as exercising control over Indian operations.
• Carve out Indian operations. Establish functionally separate entities with localized decision-making and accounts. Ensure that the contracts are aligned and don’t blur the boundaries.
• Strengthen transfer pricing. Develop robust methodologies to attribute profits to Indian operations. This would entail specifically isolating India-derived revenues from global spillovers to defend against source-based taxation.

The Road Ahead

The two aspects that would be non-negotiable, especially for arrangements already in place, are contract restructuring and robust documentation. With India’s position as a global investment hub, aligning with these principles for multinationals is not just mere compliance but a business reality that shouldn’t be ignored.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Aditya Singh Chandel is partner and Akshat Jain is an associate with AZB & Partners in India.

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